Clergy Tax

Properly Handling Minister's Paycheck

How to handle clergy taxes and compensation is always a big concern for churches. Some churches do not even know that clergy (ministers/pastors) compensation and payroll taxes are handled differently than any other profession in the United States. See how to determine if the IRS classifies your minister a "minister" under the tax laws and how to handle their payroll taxes below...

Factors to Consider Regarding Clergy Tax:

Clergy Taxes

Is the church required to hold out federal and state income tax from a minister's paycheck?

How about Social Security and Medicare taxes? Is the church required to match the FICA tax?

Is their compensation taxable?

What is the SECA system?

A minister's tax situation is unique and as church administrators residing in the United States, it is imperative that we know the IRS's tax laws regarding minister or clergy taxes!

But first and foremost.....

The Church Accounting: How To Guide devotes a whole section of the book to payroll for churches. It covers payroll terminology and forms and then takes you through the steps necessary to set up a payroll, calculate and file the necessary taxes and forms, and even details how to handle the minister's payroll. It also includes sections on filling out IRS forms: 1099 and 1096.

If you have QuickBooks or are considering using it in the future, go ahead and purchase the QuickBooks for Churches and the How To Guide combo for a complete package on setting up and administering a payroll using QuickBooks.

QuickBooks for Churches & Church Accounting Combo Bundle

Clergy Tax Factor 1: Determination

In order to be classified a minister (clergy) for tax purposes, a minister should satisfy five separate tests:

  1. Be licensed or ordained
  2. Administer the sacraments of the church (weddings, funerals, baptisms, and communion, etc...)
  3. Be considered a religious leader by the church
  4. Conduct religious worship
  5. Have management responsibilities in the church

NOTE: a Pastor is almost always considered a clergy for tax purposes.

Note: In 2012, the Supreme Court broadened the ministerial exception by stating the Church should be free to select its ministers entirely free of government regulation and that the state should “defer to a religious organization’s good-faith understanding of who qualifies as a minister.”   

Clergy Tax Factor 2: Special Tax Treatment

Clergy receive special tax treatment for the following three topics:

  1. Ministers pay their own self-employment tax.(Even though ministers can be considered church employees, they are treated as self-employed for Social Security and Medicare tax purposes. See more below)
  2. Ministers can receive a Housing Allowance and/or live in a church provided parsonage. (The value of both of these are excluded from a minister's calculation of income tax...but still subject to self-employment tax)
  3. Churches cannot withhold Social Security and Medicare tax from a minister's paycheck.

See IRS Topic 417 and Pub 517 for more clarification on minister's taxes.

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Minister taxe

Clergy Tax Factor 3:  Self-employment Tax

Like I stated in the beginning of this article...ministers are unique and their compensation is handled differently from other church staff such as the secretary, treasurrer, nursery worker, etc. The IRS considers minister to have a 'dual status" when it comes to their employment status. 

The IRS considers ministers to be employees of their churches for federal income tax purposes and self-employed for Social Security and Medicare purposes.

What this boils down to is that ministers pay their SS and Medicare taxes through the SECA system instead of the FICA system that most employees are under.

I know...you are scratching your head and wondering what in the world is SECA and FICA!

Well...let me try to spell out what those acronyms stand for and what the difference is between them...

  • SECA is an acronym for the Self-Employment Contributions Act. It is the system that self-employed individuals like myself pay our Social Security/Medicare taxes through.
  • FICA is an acronym for the Federal Insurance Contributions Act. It is the system that MOST employees in the United States are under ... including your secretary, treasurer, nursery worker, etc.. With FICA the employee and the employer each pay half of the taxes.

No earnings are subject to both systems!

Ok...we have establish the fact that most ministers are under the SECA system ... if they meet the guidelines discussed earlier in this article.

So what does that mean to the individual handling their compensation?

It means that unlike your non-minister employees, your church cannot withhold half of the Social Security and Medicare tax from a minister employee’s paycheck. The church also does NOT match any FICA tax as none is held out.

Instead, a minister employee is responsible for paying his own self-employment tax. The self-employment tax consists of 12.4% for Social Security and 2.9% for Medicare (15.3% combined).

 As a result, the minister employee actually pays twice as much Social Security and Medicare as a non-minister employee. 

In most circumstances the amount of the minister’s income that is subject to the self-employment tax includes the base salary, the housing allowance, and the fair rental value of church provided housing, if any.

An example of what a minister could expect to pay in self-employment tax:

32,000 (base salary) plus and an additional $14,400 (housing allowance)= $46,400 times 15.3% =$7048 (Note: This amount does not include the minister's income tax)

Some churches will include a "Social Security Tax Allowance" in a minister's compensation package to help off set this burden. That is perfectly legal...BUT be aware that the "allowance" is taxable income and MUST be included in Box 1 of his W-2.  So many churches figure that allowance at 9.8% of their salary {7.65% (half of their SE tax) plus the additional amount to help with the additional taxes they owe when their salary is increased}.

See an example of a Pastor's W-2 that has a Social Security Allowance as part of the compensation package.

Clergy Tax Factor 4: Opting Out

A minister can opt out of paying in Social Security, but he must do it by the second year in which he earned more than $400 of ministerial income.

IRS Form 4361 must be used and it must be filed on the correct basis of religious belief. If approved by the IRS, only earnings from ministerial services are exempt from self-employment tax. Form 4361 indicates that once the exemption is approved, you cannot revoke it.

Clergy Tax Factor 5 - Withholding Taxes

A church can withhold income tax (at the minister requests), but not Social Security and Medicare tax. Let me repeat that...a church CANNOT withhold FICA from a qualifying minister's compensation.

As I stated earlier in this article, minister pays the Social Security and Medicare tax himself under the SECA system. He can pay this tax by making quarterly estimated tax payments, or by requesting the church to hold out extra income tax.

The minister who is considered a church employee must complete a form W-4 and request that a specific amount be withheld from each paycheck.

For example, if a minister estimates that his combined income and self-employment tax for the year will be $9600. He can request that the church withhold $800 of income tax from each month's paycheck.

Even though the minister can only elect withholding of income taxes, he can use these tax payments against both income and self-employment tax since they are added together on his personal income tax return (Form 1040).

*Important: You cannot withhold taxes from ministers' pay without the minister's authorization. Ministers are exempt from income tax withholding whether they report their income taxes as employees or self-employed; ministers who report their income taxes as an employee can request voluntary withholding by submitting a Form W-4 to the church.

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Church Accounting Package

A set of 4 ebooks that covers the following topics...

  • Fund Accounting Examples and Explanations
  • Setting up a fund accounting system
  • Donation management
  • Minister compensation and taxes
  • Internal controls and staff reimbursements
  • Much more - Click here for details

Reference:

Supreme Court unanimously shoots down Obama admin in religious freedom case

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